Class action lawsuits based on the federal securities laws continue to be filed in 2018 at record pace, and nearly half of all securities class actions filed in 2018 were M&A cases. These M&A cases tend to take a familiar form: Shareholder plaintiffs object to a merger shortly after a transaction is announced, claiming that they will suffer immediate harm if a shareholder vote to approve the merger takes place or if the deal closes without the disclosure of a long list of superfluous information that was not included in the proxy. While the Delaware Chancery Court grew wary of routine M&A filings and modest disclosure-only settlements a couple of years ago, the plaintiffs’ bar sought refuge in the federal courts by crafting their breach of fiduciary duty claims as violations of the federal securities laws. Recent decisions from federal courts around the country, however, indicate that this may not be a viable path for these nuisance suits either, as courts are pressed to take a hard look at the plaintiffs’ legal burdens to enjoin shareholder votes when defendants refuse the plaintiffs’ shakedown for additional disclosures of non-material information.
Trulia Shakes Things Up
In years past, companies routinely settled M&A cases through supplemental disclosures in advance of the shareholder vote in exchange for a classwide release and a fee paid to plaintiff’s counsel. And courts routinely approved these disclosure-only settlements. This practice was widespread, and in-house counsel became accustomed to thinking of these types of merger-objection lawsuits as part of the cost of doing business—a “deal tax.” The fees paid to settle these claims were typically small compared to the value of the proposed deal and, many times, covered by directors’ and officers’ insurance.
In 2016, Chancellor Andre Bouchard of the Delaware Chancery Court notably criticized merger-objection cases and the disclosure-only settlements that customarily accompanied them in his rejection of a disclosure-only settlement in connection with Zillow’s acquisition of Trulia. In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016). He pointedly remarked that such disclosure-only settlements had “become the most common method for quickly resolving stockholder lawsuits that are filed routinely in response to the announcement of virtually every transaction involving the acquisition of a public corporation.” Trulia, Inc., at 887. Bouchard declined to approve the proposed settlement largely due to his view that “the settlement will not provide Trulia stockholders with any economic benefits. The only money that would change hands is the payment of a fee to plaintiffs’ counsel.” Id. In no uncertain terms, he decreed that the Delaware Chancery Court’s practice of approving disclosure settlements needed to evolve, and he hoped that his decision would directly impact when such M&A cases are brought by shareholders and how they are resolved by the parties. Id. at 899.
Bouchard’s stated goal was to deter plaintiffs from filing meritless M&A lawsuits or to encourage them to vigorously pursue their claims if they felt companies were deliberately leaving shareholders in the dark about material deal terms. But while it has led to a stark decline of such filings in Delaware Chancery Court, it has driven the plaintiffs’ bar to re-invent state law breach of fiduciary duty claims as federal securities laws violations and bring suit in federal court.
Creative Plaintiffs Seek Shelter for M&A Claims in Federal Court
Since 2016, we’ve seen plaintiffs’ counsel turn more frequently to the federal courts to save them from the scrutiny of the Delaware Chancery Court. Could it be that fewer Delaware corporations are being sued? Not likely. Instead, the plaintiffs’ bar would rather take their chances before a federal judge who may not have as much experience with these cases, or may not feel bound to follow Bouchard’s lead. This explains why, according to Cornerstone Research, M&A filings constituted 46 percent of all federal securities class actions in the first half of 2018.
The allegations in these cases are similar to the cases seen in Delaware in years past, but they have been reborn as claims that the directors and officers violated Sections 14(a) and 20(a) of the Securities Exchange Act of 1934. The conduct complained of is still based on allegedly material information that was omitted from or mispresented in the proxy materials, and the remedy sought is still additional disclosures made in advance of the shareholder vote. By asserting Section 14(a) and 20(a) claims, however, plaintiffs gain entrance to the federal courts. For a short while it seemed that this creative shift in pleading was an effective strategy. Several recent decisions, however, indicate that federal judges are starting to press these shareholder plaintiffs to bring serious claims or get out of their courts.
The Federal Courts May Be Losing Patience
When companies refuse to provide the additional disclosures demanded in M&A cases, plaintiffs may seek a preliminary injunction in the days immediately preceding a shareholder vote in order to gain settlement leverage. The federal standard for a preliminary injunction is more difficult for plaintiffs to satisfy, however, because much of the favorable case law the plaintiffs’ bar developed in Delaware before Trulia doesn’t apply to federal courts bound by federal law interpreting Fed. R. Civ. P. 65. See also Winter v. NRDC, Inc., 555 U.S. 7 (2008) (finding that a plaintiff seeking a preliminary injunction must establish all four of the following criteria: (1) the plaintiff is likely to succeed on the merits, (2) the plaintiff is likely to suffer irreparable harm in the absence of preliminary injunctive relief, (3) the balance of equities tips in the plaintiff’s favor, and (4) the injunction is in the public interest). Three recent notable decisions raise the question of whether plaintiffs will need to rethink their strategy of filing in federal court.
In July 2017, the U.S. District Court for the District of South Carolina denied a plaintiff’s emergency motion for a preliminary injunction six days before the shareholder vote on the merger of HCSB Financial Corporation and United Community Banks, Inc. The court stated that because injunctive relief is only appropriate in extraordinary circumstances, “a plaintiff must make a clear showing that it is likely to succeed on the merits of its claim,” and “that it is likely to be irreparably harmed absent injunctive relief.” Parshall v. HCSB Fin. Corp., No. 4:17-cv-01589, 2017 BL 255781, at *5 (D.S.C. July 24, 2017). The court found that the plaintiff failed to meet his burden of proof for each element required for a preliminary injunction. Id. The court was particularly critical of the fact that Parshall owned “a minuscule share of HCSB stock,” was not present at the hearing, and did not submit an affidavit from an expert or himself in support of his papers explaining why the alleged omissions were material to the shareholders. Id. at *8–9.
The court also acknowledged that this particular shareholder plaintiff, Paul Parshall, had filed 32 similar suits in that year alone. Id. at fn 3. Parshall has been quite busy since this decision, already filing at least 13 merger objection suits in 2018. Parshall, a Florida resident, told the Napa Valley Register last year that he researches companies that look to be likely candidates for a merger and buys stock before a deal is announced. He pursues merger objection claims in numerous jurisdictions across the country. “I’ve got a lot of them pending,” Parshall said. “That’s what I do.” And he’s not the only one. More and more of these suits are filed by repeat players who own a handful of shares of a host of companies. The viability of this career path, however, may get less clear the more closely federal courts look at these cases and evaluate people like Parshall as “a single disgruntled stockholder with a de minimis ownership interest” who cannot “show why monetary damages are not an adequate remedy.” Id. at *9 (internal citations omitted).
Six months after the federal court in South Carolina shot Parshall down, three shareholders in possession of de minimis amounts of stock attempted to enjoin the vote on the merger of LHC Group, Inc. and Almost Family, Inc. The U.S. District Court for the Western District of Kentucky was similarly unimpressed with the plaintiffs’ rote arguments and denied their motion for a preliminary injunction a week before the shareholder vote. Stein v. Almost Family, Inc., No. 3:18-cv-00129, 2018 BL 98339 (W.D. Ky. Mar. 21, 2018).
Focusing on whether the harm alleged is both certain and great, the court found that the plaintiffs had not met their burden. While the plaintiffs argued that courts favor equitable relief in the form of an injunction when the harm may not be fully compensable, the court found that it “does not move Plaintiff’s harm from the theoretical realm and into realm of certainty.” Id. at *10. Just as in Parshall, the court took note that the plaintiffs failed to present any evidence—expert opinions or evidentiary affidavits—in support of their motion and failed to present any testimony at the hearing. “The entire premise of Plaintiff’s lawsuit appears to depend on the notion that the merger will inevitably result in an undervaluation of Almost Family stock and, consequently, an unfavorable premium being placed on Almost Family stock after the merger is effectuated. There is no direct evidence before the Court which tends to support that contention.” Id. at *11. Such unsupported, speculative harm is plainly insufficient to warrant the extraordinary remedy of a preliminary injunction.
Federal courts also recognize the potential risk to all shareholders if the vote (and potentially the whole deal) is jeopardized through a hastily submitted emergency motion for preliminary injunction. The Kentucky court was “cognizant of the fact that, should an injunction be granted, a knot could be thrown into the proposed $2.4 billion merger … the harm to Almost Family and LHC shareholders is something the Court must consider in weighing the four preliminary injunction factors.” Id. at *12. The court ruled that the public interest would not be served by enjoining a premium-generating transaction or requiring the disclosure of immaterial information. Id. at *13.
A federal court in North Carolina followed the Kentucky court’s lead and rejected a shareholder’s attempt to enjoin the sale of Triangle Capital Corp.’s assets to Benefit Street Partners LLC. Carlson v. Triangle Capital Corp., No. 5:18-cv-00332, 2018 BL 259892 (E.D.N.C. July 23, 2018). Once again, a de minimis shareholder filed a motion for preliminary injunction within days of the shareholder vote based on the assertion that the proxy materials omitted material information about the financial advisor’s analysis. Citing to Stein, the court found that “no public interest would be served by the issuance of a preliminary injunction or further disclosures containing information that is either already disclosed or not material on the eve of a long-scheduled stockholder vote.” Id. at *10.
The court further clarified an important point that sometimes gets lost in M&A litigation. Companies do not have a duty to disclose “information so extensive and detailed as to permit stockholders to make an independent determination of fair value or recreate the analysis of a financial advisor.” Id. at *6. There will always be details that do not make it into the proxy materials, but the key issue is supposed to be whether those details are material and would significantly alter the total mix of information made available. The federal courts are looking closely at these issues, and plaintiffs are failing to chin to the bar.
What Comes Next?
As merger litigation case law continues to develop in this post-Trulia world, plaintiffs will continue to adjust their filing strategy and shop around different jurisdictions. Just as we saw a drastic drop in disclosure merger claims in the Delaware Chancery Court, we may see merger litigation activity level off in the federal courts as courts continue to put up roadblocks for prolific plaintiffs with hollow claims. In the meantime, to employ a successful defense strategy, in-house counsel should consider the following lessons from these recent federal court decisions:
- Companies need not disclose every possible detail of a deal to shareholders. Companies are entitled to rely on financial advisors and need not disclose so much detail that each shareholder could perform their own independent determination of fair value.
- Companies should evaluate the track record of the plaintiff pursuing your deal. Courts may have little patience for serial plaintiffs who can’t articulate why they will be harmed if your merger closes and fail to engage experts to lend credibility to their positions. Along the same lines, take note of the percentage of shares owned by the complaining shareholders and bring their minuscule holdings to the court’s attention.
- Companies should remember, when facing the possibility of a preliminary injunction hearing, that plaintiffs are asking for extraordinary relief from the court and will need to show certain, great, and imminent harm that will be difficult for them to do in most circumstances.
Above all, take comfort that in this rapidly evolving legal area, you may not have to pay a “deal tax” to plaintiffs to prevent your deal from being interrupted.
Robert R. Long, partner in the firm’s Atlanta office, has defended corporations and financial institutions in securities class actions, regulatory actions, and internal investigations. Elizabeth Gingold Clark, a senior associate in the firm’s Atlanta office, represents directors and officers of publicly held companies and distressed financial institutions in complex civil disputes.